What Is The Magic Of EBITDA?
If you’re running a business, you know about EBITDA.
If the term seems mystical, the Corporate Finance Institute defines EBITDA as “Earnings Before Interest, Taxes, Depreciation, and Amortization and is a metric used to evaluate a company’s operating performance. It can be seen as a proxy for cash flow from the entire company’s operations.”(1)
When a business owner begins to prepare for the sale or transfer of their business, EBITDA is a big part of the equation.
But which EBITDA multiple is the correct one for your business? It’s helpful to have an expert in business valuation and finance at this point in the transfer process.
First, let’s review how EBITDA is calculated. Again, according to the Corporate Finance Institute, “The EBITDA metric is a variation of operating income because it excludes non-operating expenses and certain non-cash expenses.” (2)
EBITDA = Net Income + Taxes + Interest Expense + Depreciation and Amortization
When evaluating a business, buyers typically look at this metric as a proxy for cash flow.
During the evaluation of a company, the EBITDA metric can give a quick estimate of a company by multiplying it by a valuation multiple received by equity research reports, industry transactions, or Mergers and Acquisitions. (3)
In the valuation process, the Enterprise Value/EBITDA ratio is used to understand a company’s value. To calculate this ratio, divide the company’s enterprise value by EBITDA.
The result of this operation is a ratio that signals whether a company is over- or under-valued. If the company is overvalued, it has a higher ratio, undervalued a low ratio.
Please remember to evaluate companies that are similar in nature – the same industry, customers, and margins among other characteristics. Different industries have different average ratios.
For example, a capital-intensive business such as manufacturing or oil and gas typically trade at a very low EV/EBITDA multiples since their depreciation expense and capital needs are high. This low multiple may infer the company is inexpensive, but that is probably not true. It’s important to have professional guidance when using these tools.
As a business owner considering a transfer of a business, understanding and using the EBITDA multiples is important. If you’re not quite ready to dig into a spreadsheet to work the magic of the calculations, software can help.
Using Forward Insights, get a sense of your company’s EBITDA multiple as well as understanding the other drivers of company value.
Need to know more? Contact us today.
Want to know more about the value of your company? Rest assured 35 years of experience is behind Management Insights™, Forward Insights™, and Expert Insights™ – the tools you can use to increase the value of your company.
((1) What is EBITDA, n.d.)
((2) What is EBITDA, n.d.)
((3) What is EBITDA, n.d.)
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